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Joint effects of the liability network and portfolio overlapping on systemic financial risk: contagion and rescue

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  • J. L. Ma
  • S. S. Zhu
  • Y. Wu

Abstract

We examine the conjoined contagion mechanism of the inter-liability network and portfolio overlapping in shaping systemic financial risk. We first develop an iterative algorithm to compute the largest clearing payment vector and price vector, and prove its existence and continuity. A concrete form of total wealth loss is then derived to specify the joint effects of the inter-liability network and portfolio overlapping. Next, we show how inter-institutional liability connections and portfolio diversification can amplify the impact of initial negative shocks and lead later to financial crisis. We prove that illiquidity is a critical factor in triggering risk contagion and that higher inter-institutional leverage can cause larger losses for both the institutions and the outside obligees. Based on the theoretical findings, we propose a rescue strategy via solving a series of linear programs and conclude with some practical suggestions for the management of systemic financial risk.

Suggested Citation

  • J. L. Ma & S. S. Zhu & Y. Wu, 2021. "Joint effects of the liability network and portfolio overlapping on systemic financial risk: contagion and rescue," Quantitative Finance, Taylor & Francis Journals, vol. 21(5), pages 753-770, May.
    • Handle: RePEc:taf:quantf:v:21:y:2021:i:5:p:753-770
    DOI: 10.1080/14697688.2020.1802054
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    Cited by:

    1. Barnett, William A. & Wang, Xue & Xu, Hai-Chuan & Zhou, Wei-Xing, 2022. "Hierarchical contagions in the interdependent financial network," Journal of Financial Stability, Elsevier, vol. 61(C).
    2. Qian, Qian & Chao, Xiangrui & Feng, Hairong, 2023. "Internal or external control? How to respond to credit risk contagion in complex enterprises network," International Review of Financial Analysis, Elsevier, vol. 87(C).
    3. Wang Yijun & Zhang Yu & Usman Bashir, 2023. "Impact of COVID-19 on the contagion effect of risks in the banking industry: based on transfer entropy and social network analysis method," Risk Management, Palgrave Macmillan, vol. 25(2), pages 1-41, June.
    4. Ahn, Dohyun & Kim, Kyoung-Kuk & Kwon, Eunji, 2023. "Multivariate stress scenario selection in interbank networks," Journal of Economic Dynamics and Control, Elsevier, vol. 154(C).

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